Gas Money What to Do With It?

6/15/2013 7:00 AM

Few would argue that it is much more fun to have excess cash than not enough. But a sudden influx of cash from the lottery, inheritance or gas royalties creates its own kind of anxiety. What is the right thing to do with the money? How do I make sure that I keep as much as possible for the future? What will I owe in taxes? And how will it affect my family? These are all valid concerns currently being faced by many Pennsylvania farm families in the Marcellus Shale Gas belt.

In a recent conversation with a client, the farm owner voiced these very concerns. What follows is a summary of our discussion.

Taxes

I will begin with taxes, as they are the easiest to understand. Upon receipt of the initial check and before anything else is done, the farm owner needs to sit down with their accountant and determine the amount of money that must be set aside for taxes. In most cases, this will involve federal income taxes and Pennsylvania income taxes. Given that everyone is different, this could be a very short meeting or a complex series of meetings.

I am not going to get involved here with all of the fancy entities like partnerships, family limited partnerships, limited liability companies and the like that are being used to meet family goals and limit some of the tax burden. My point is simply that the first adviser to call is the accountant, so the tax man is satisfied.

Financial Situation Review

Next, a review of the current financial situation of the farm owner needs to be undertaken. What is the current debt load? What is the level of financial sophistication of the farm owner in the area of investments? This review must be done by someone the farm owner trusts, as the results will guide most of the remaining decisions.

Investing

One thing is true about newfound wealth, and that is that the farm owner will quickly discover “friends and advisers” that they never knew they had who are all too willing to help. Individuals that a month earlier would not give them the time of day will suddenly be ready to help them any time of the day or night. Money has a way of doing that, so great care is needed.

There are honest good advisers and those who are not, and no obvious way to distinguish between the two. When choosing an adviser ask, “How is this advisor compensated?” If the answer is results, great. If the answer is transactions, not so good.

To help with what is a very important and difficult decision process, and as an accountant that has witnessed success and failure in this area, I offer the following tips that should help:

If the farm has debt, pay it off (after holding back enough for taxes). This will result in a guaranteed return to the owner of whatever interest rate they were paying (net of the owner’s taxes that would have been saved). Paying 6 percent on a mortgage should yield at least a 4 percent return, and free up the mortgage payment amounts each month from then on. Paying off a feed bill will yield a much greater return in most cases.

Most farm owners are very good at putting off personal luxury purchases. This is the time to treat yourself to some of those items that you never seemed to have the cash for. Just try to hold these purchases, which can get out of control very quickly, to 10-20 percent of any one check. Never spend the next check before it arrives.

Leave all excess funds in the bank, while you educate yourself. Read, go to seminars, and take a class at a local college. Investing has its own vocabulary of terms, mindboggling expenses and agreements written by big-city attorneys. The recently wealthy are at a distinct disadvantage, a disadvantage used against them by advisers and brokers all the time.

Once investing begins, never, never, never give more than 25 percent of your wealth to one adviser, or place it in one category of investment. And if investing in individual stocks or bonds, stay below 5 percent. The best advice in this area I have ever heard was a person should invest only in what they know. For the farm owner this would include land, cattle and perhaps other farm enterprises.

Now that investing is under way, never chase yields. The newly wealthy should have as their number one concern: wealth preservation. Yield (rate of return) is directly inverse to risk. Are these funds the farm owner should risk? Only they know their risk tolerance level. But remember that royalties are generated by the sale of an asset, the gas. Once the gas is gone, it is gone. This makes the only logical course of action the careful preservation of the cash generated.

The Marcellus Shale is a great blessing entrusted to Pennsylvania, and if the resulting wealth is properly handled, it will be a blessing for generations to come.

Editor’s Note: Michael Evanish is the manager of MSC Business Services, a member service of the Pennsylvania Farm Bureau.